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So once again the average hedge fund return was below a simple buy and hold strategy on the S&P 500. This is not how it should be perhaps, especially with the no load funds that can give you exposure to that S&P rather than the 2 % of assets and 20% of profits fees that are standard in the hedge fund world. However, despite that we can actually look to Adam Smith for an explanation: even though he published 240 years ago, his explanation is still true.

Based on preliminary data for performance in December for hedge funds in the Barclay database, the S&P 500 Index out-performed the return on the average hedge fund last year by 1.36% to 0.42% (subject to further minor revisions). That marked the 7th straight year, and the 10th year out of the last 13 years, that the return on the S&P 500 was greater than the return on the average hedge fund.

So, what is it that is happening here? The answer is, as Smith pointed out, the combination of three things. That capitalists are observant, that capitalists are greedy and that markets sometimes to often overshoot. With those three, and those three alone, we can explain what is going on here.

That capitalists are greedy is obvious. You can take your mental image from Scrooge McDuck surfing down his mountain of gold coins or you can think of boring exploiter in a suit determining how best to screw the people in order to increase his profits. No doubt cackling maniacally as he stubs his cigar out on the naked back of some poor waif grovelling at his feet for gruel. But capitalists like profits and the more profit the better.

That capitalists are observant is also obvious. The moment introduced the iPhone half the world was off trying to replicate that success. Even to the point of Samsung copying those rounded corners, something they obviously thought essential to the success of a smartphone.

That markets overshoot is also tediously obvious. If we look at smartphones again (and my data is a year or more out of date) then Apple and Samsung between them make more than all of the profits of the entire industry for all of the other squiddelyelebenty copycats are losing money.

At which point we can put our story together. Capitalists are greedy, so they're always on the look out for ways to make higher profits. Capitalists are observant, meaning that they note when someone does work out a way to make more profits. We generally call this people making "excess" profits, or profits above the normal return to capital. At which point the other capitalists pile in and copy that first one in the hope of gaining some of those excess profits. More people doing the same thing is also called increased competition and that competition brings the profits back down again.